What if Grantham is Right?

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There were two articles recently both exploring the same possible outcome; that investor returns from capital markets could be much lower in the coming years.

The first article was from the Wall Street Journal with the title How Safe Are Your Investments, Really? And the other was an interview with Jeremy Grantham in Barron’s.

Included in the WSJ piece was the following;

Strip out these one-off gains and inflation, Rob Arnott recently suggested, and investors ought more realistically to expect about 1.5% a year plus dividends—meaning, in the current environment, an annual return of about 3.5% in real terms. That's a far cry from 10%.

One of the many takeaways from the Grantham interview was the reiterated expectation of 1.7% annualized growth for US equities.

The point of these articles is not to agree or disagree with the conclusions drawn, after all things have not played out as Grantham has expected very often (not an obstacle to returns), but to think about how to manage a portfolio (either for clients or as an individual) if either Arnott or Grantham turn out to be correct.

No matter what markets end up doing, advisory clients and do-it-yourselfers still have financial plans that likely require some amount of growth over time in order to have a chance of succeeding without something, such as desired lifestyle or working longer than hoped for, having to give.

While there can be no assurances of success there of course have been long stretches where market growth has been low single digits and of course there will be such periods again which creates the possibility that now is one of those times.

Times of low returns, whether that is now or not, requires broader investment horizons terms going back to asset allocation and considering asset classes that seem to be less important in a five year stretch where the S&P 500 goes up 143% but are crucial in periods like the five years going into the March 2009 low when the S&P 500 was down 33%.

This can include absolute return, foreign equities, select hedge fund replication (some of these do work well), funds that employ some sort of screening methodology to build a portfolio (these could be just as important for what they avoid as what they include), options strategies, commodities and even currencies.

Portfolio success from that five year period going into 2009 came from including these other assets, assets which have been shunned since for not keeping up with US equities. No asset class will lead forever and no asset class will lag forever and the next time domestic equities rotate out of favor clients will expect advisors to have a plan to mitigate that environment and it will likely have to include the above mentioned out of favor market segments.

Source: Google Finance

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